Term structure information and bond strategies

We examine term structure theories by using a novel approach. We form bond investment strategies based on different theories of the term structure in order to determine which strategy performs best. When using a manipulation-proof performance measure, we find that consistent with prior literature, a...

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Bibliographic Details
Published in:Review of quantitative finance and accounting 2013-07, Vol.41 (1), p.53-74
Main Authors: de la O González, María, Skinner, Frank S., Agyei-Ampomah, Samuel
Format: Article
Language:English
Subjects:
Accounting/Auditing
Bond market
Bond portfolios
Corporate Finance
Econometrics
Economics and Finance
Expectation
Finance
Hypotheses
Interest rates
Investment
Investors
Kurtosis
Measurement techniques
Operations Research/Decision Theory
Original Research
Performance evaluation
Portfolio analysis
Simulation
Skewness
Time series
Treasuries
Yield curve
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Summary:We examine term structure theories by using a novel approach. We form bond investment strategies based on different theories of the term structure in order to determine which strategy performs best. When using a manipulation-proof performance measure, we find that consistent with prior literature, an active strategy that is based on time varying term premiums can indeed form the basis of a successful bond strategy that outperforms an unbiased expectation inspired passive bond buy and hold strategy. This is true, however, for an earlier time period when the literature first made this claim. In a later time period, we find that the passive buy and hold strategy is significantly superior to all active strategies. This result is confirmed by statistical tests and it suggests that once it became known that an active strategy based on time varying term premiums could outperform a passive buy and hold strategy, the markets adjusted and arbitraged away this opportunity. Overall, it appears that the unbiased expectation hypothesis is the most likely explanation of the behaviour of the term structure during more recent times. This is because economically and statistically significant superior performance cannot be achieved if one uses information from the forward curve or the term structure as a guide to adjusting bond portfolios in response to changes in the term premium.
ISSN:0924-865X
1573-7179
DOI:10.1007/s11156-012-0300-5